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What Length of Retirement Should I Plan For?

A reader writes in, asking:

“I’m currently age 55, considering retirement in the nearish future. I am trying to determine the length of retirement I should be planning for. The SSA Actuarial Life Table indicates that if I retired today, I’d have an ‘average’ retirement length of 25 years. Of course I should plan for longer than that, because I have a 50% chance of living past my life expectancy. But how much longer should I be planning for?”

The answer is, “it depends.” But first we need to spend a minute talking about life expectancy in general.

Period Life Tables vs. Cohort Life Tables

A “period life table,” such as the table provided by the SSA, uses data about deaths in a given year. For example, in 2017 it would look at how many people age 65 died in 2017, and how many people age 66 died in 2017, and how many people age 67 died in 2017, etc. And it then uses those figures to determine the probability of any giving person dying at age 65, 66, 67, etc.

The upside here is that we’re using actual, verifiable data.

The downside is that we’re conflating different birth cohorts. For example, if we want to know the life expectancy of a person who is currently age 20 in 2017, just how relevant is the likelihood of a current 65 year old dying this year? There are another 45 years until our current 20 year old reaches age 65, and a lot of medical progress could happen between now and then.

In contrast, a “cohort life table” uses actuarial projections about people born in a certain year. That is, it includes assumptions about how mortality rates will change over time.

Point being: A period life table is always going to understate a person’s life expectancy, assuming life expectancies continue to grow over time. A cohort life table should provide a better estimate of an actual person’s life expectancy.

Personally, I am a fan of the Longevity Illustrator tool as a quick way to get a good estimate of your life expectancy, as well as your probability of living to various ages. The tool was jointly created by the Society of Actuaries and American Academy of Actuaries, and it uses the SSA’s mortality data, with adjustments to reflect projected improvements in mortality rates over time.

How Are You Different from Average?

The average life expectancy is a useful place to start, but you likely have information about yourself that suggests that the average life expectancy is not your life expectancy. You likely have specific information about your health being better or worse than average. (The Longevity Illustrator mentioned above gives you a little flexibility here, as it allows you to select excellent/average/poor for your health status, and allows you to select smoker/nonsmoker.)

Even something as simple as your education/income level tells you something about your expectancy. For example, as we discussed a couple of years ago, if we look at women age 50-74, for those with a college degree, the mortality rate (i.e., the likelihood of dying in a given year) is 49% lower than the average mortality rate. In other words, if you’re a woman between the ages of 50 and 74 and you have a college degree, you are only half as likely to die each year as the average woman in your age bracket.

Longevity Risk Tolerance

Finally, after having information about your longevity projections, the appropriate retirement planning horizon depends on your personal tolerance for longevity risk. That is, how sure do you want to be that you will not outlive your portfolio?

For example, if funding retirement with a bond ladder, one person might want to build the ladder out to the point where she’s 99% sure she won’t outlive the ladder. Somebody else might be comfortable with a 75% chance, because she places a higher value on current spending and she is OK with the possibility of a cut in spending at a later point in retirement. Either approach might be perfectly reasonable.

To some extent this decision is personal preference, but there are also important financial factors as well.

Example: Alice has $30,000 of inflation-adjusted safe income between her Social Security and her pension. She also owns her home and has paid off her mortgage. Betsy has $15,000 of Social Security, no other safe income, and she rents her home. Betsy is in a much worse position if she outlives her portfolio than Alice would be.

So, to summarize, when determining the length of retirement to plan for:

Be sure to use information from a cohort life table (or at least recognize that a period life table is understating your life expectancy somewhat),

Be sure to account for any information you have that makes your life expectancy different from average, and

Use your life expectancy projection to pick a planning horizon that matches your tolerance for longevity risk.

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